UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2018
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________
Commission File Number 001-38154
CODA OCTOPUS GROUP, INC.
(Exact name of registrant as specified in its charter)
| Delaware | 34-200-8348 | |
| (State or other jurisdiction of | (I.R.S. Employer | |
| Incorporation or organization) | Identification Number) |
| 9100 Conroy Windermere Road, Suite 200, Windermere, Florida | 34784 | |
| (Address of principal executive offices) | (Zip Code) | |
| Registrant’s telephone number, including area code: | (863) 937 8985 |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one): [ ]
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of shares outstanding of issuer’s common stock, $0.001 par value as of September 13, 2018 is 10,415,416.
INDEX
| 2 |
CODA OCTOPUS GROUP, INC.
July 31, 2018 and October 31, 2017
| 2018 | 2017 | |||||||
| Unaudited | ||||||||
| ASSETS | ||||||||
| CURRENT ASSETS | ||||||||
| Cash and Cash Equivalents | $ | 6,711,263 | $ | 6,851,539 | ||||
| Accounts Receivables, Net | 3,761,948 | 1,418,114 | ||||||
| Inventory | 4,187,906 | 3,652,249 | ||||||
| Unbilled Receivables | 2,349,871 | 2,723,172 | ||||||
| Other Current Assets | 113,859 | 320,814 | ||||||
| Prepaid Expenses | 184,811 | 291,623 | ||||||
| Total Current Assets | 17,309,658 | 15,257,511 | ||||||
| FIXED ASSETS | ||||||||
| Property and Equipment, net | 5,039,221 | 5,213,281 | ||||||
| OTHER ASSETS | ||||||||
| Goodwill and Other Intangibles, net | 3,599,737 | 3,589,281 | ||||||
| Total Assets | $ | 25,948,616 | $ | 24,060,073 | ||||
The accompanying notes are an integral part of these consolidated financial statements
| 3 |
CODA OCTOPUS GROUP, INC.
Consolidated Balance Sheets (Continued)
July 31, 2018 and October 31, 2017
| 2018 | 2017 | |||||||
| Unaudited | ||||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| CURRENT LIABILITIES | ||||||||
| Accounts Payable | $ | 825,874 | $ | 981,994 | ||||
| Accrued Expenses and Other Current Liabilities | 627,936 | 519,208 | ||||||
| Loans and Note Payable, current | 1,459,326 | 2,212,951 | ||||||
| Deferred Revenue, current | 281,037 | 402,955 | ||||||
| Total Current Liabilities | 3,194,173 | 4,117,108 | ||||||
| LONG TERM LIABILITIES | ||||||||
| Deferred Revenue, long term | 44,805 | 49,143 | ||||||
| Loans and Note Payable, long term | 1,177,825 | 6,066,402 | ||||||
| Total Long Term Liabilities | 1,222,630 | 6,115,545 | ||||||
| Total Liabilities | 4,416,803 | 10,232,653 | ||||||
| STOCKHOLDERS’ EQUITY | ||||||||
| Preferred stock, Series C, $.001 par value; 5,000,000 shares authorized, 1,000 shares issued and outstanding, as of July 31, 2018 and October 31, 2017 | 1 | 1 | ||||||
| Common stock, $.001 par value; 150,000,000 shares authorized, 10,415,416 and 9,136,121 shares issued and outstanding as of July 31, 2018 and October 31, 2017, respectively | 10,415 | 9,136 | ||||||
| Additional paid-in capital | 58,485,853 | 52,839,651 | ||||||
| Accumulated other comprehensive loss | (1,733,865 | ) | (2,038,431 | ) | ||||
| Accumulated deficit | (35,230,591 | ) | (36,982,937 | ) | ||||
| Total Stockholders’ Equity | 21,531,813 | 13,827,420 | ||||||
| Total Liabilities and Stockholders’ Equity | $ | 25,948,616 | $ | 24,060,073 | ||||
The accompanying notes are an integral part of these consolidated financial statements
| 4 |
CODA OCTOPUS GROUP, INC.
Consolidated Statements of Operations and Comprehensive Income
For the Periods Indicated
Unaudited
| Three Months Ended July 31, | Nine Months Ended July 31, | |||||||||||||||
| 2018 | 2017 | 2018 | 2017 | |||||||||||||
| Net Revenues | $ | 5,778,473 | $ | 5,043,590 | $ | 12,355,426 | $ | 15,680,551 | ||||||||
| Cost of Revenues | 1,584,200 | 1,982,761 | 3,471,165 | 5,979,746 | ||||||||||||
| Gross Profit | 4,194,273 | 3,060,829 | 8,884,261 | 9,700,805 | ||||||||||||
| OPERATING EXPENSES | ||||||||||||||||
| Research & Development | 530,392 | 200,118 | 1,841,408 | 699,106 | ||||||||||||
| Selling, General & Administrative | 1,640,842 | 1,717,264 | 5,172,229 | 4,741,968 | ||||||||||||
| Total Operating Expenses | 2,171,234 | 1,917,382 | 7,013,637 | 5,441,074 | ||||||||||||
| INCOME FROM OPERATIONS | 2,023,039 | 1,143,447 | 1,870,624 | 4,259,731 | ||||||||||||
| OTHER INCOME (EXPENSE) | ||||||||||||||||
| Other Income | 3,972 | 89,931 | 94,642 | 204,914 | ||||||||||||
| Interest Expense | (29,421 | ) | (112,089 | ) | (212,910 | ) | (496,430 | ) | ||||||||
| Total Other Income (Expense) | (25,449 | ) | (22,158 | ) | (118,268 | ) | (291,516 | ) | ||||||||
| NET INCOME BEFORE INCOME TAXES | 1,997,590 | 1,121,289 | 1,752,356 | 3,968,215 | ||||||||||||
| INCOME TAX EXPENSE (REFUND) | 20 | 3,513 | (10 | ) | 3,513 | |||||||||||
| NET INCOME | $ | 1,997,610 | $ | 1,124,802 | $ | 1,752,346 | $ | 3,971,728 | ||||||||
| NET INCOME PER SHARE: | ||||||||||||||||
| Basic | $ | 0.19 | $ | 0.12 | $ | 0.18 | $ | 0.44 | ||||||||
| Diluted | $ | 0.19 | $ | 0.12 | $ | 0.17 | $ | 0.43 | ||||||||
| WEIGHTED AVERAGE SHARES: | ||||||||||||||||
| Basic | 10,415,416 | 9,110,674 |
| 9,976,917 | 9,104,890 | |||||||||||
| Diluted | 10,615,416 | 9,310,674 | 10,176,917 | 9,304,890 | ||||||||||||
| NET INCOME | $ | 1,997,610 | $ | 1,124,802 | $ | 1,752,346 | $ | 3,971,728 | ||||||||
| Other Comprehensive Income | ||||||||||||||||
| Foreign currency translation adjustment | (270,370 | ) | 13,307 | 304,566 | 781,194 | |||||||||||
| Total Other Comprehensive (Loss) Income | (270,370 | ) | 13,307 | 304,566 | 781,194 | |||||||||||
| COMPREHENSIVE INCOME | $ | 1,727,240 | $ | 1,138,109 | $ | 2,056,912 | $ | 4,752,922 | ||||||||
The accompanying notes are an integral part of these consolidated financial statements
| 5 |
CODA OCTOPUS GROUP, INC.
Consolidated Statement of Changes in Stockholders’ Equity
For the Nine Months Ended July 31, 2018
Unaudited
| Preferred Stock | Additional | Accumulated
Other | ||||||||||||||||||||||||||||||
|
Series C | Common Stock | Paid-in | Comprehensive | Accumulated | ||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Income (Loss) | Deficit | Total | |||||||||||||||||||||||||
| Balance, October 31, 2017 | 1,000 | $ | 1 | 9,136,121 | $ | 9,136 | $ | 52,839,651 | $ | (2,038,431 | ) | $ | (36,982,937 | ) | $ | 13,827,420 | ||||||||||||||||
| Stock Issued to Investors | - | - | 1,203,727 | 1,204 | 5,311,528 | - | - | 5,312,732 | ||||||||||||||||||||||||
| Stock Issued to Consultants | - | - | 12,500 | 12 | 57,238 | - | - | 57,250 | ||||||||||||||||||||||||
| Stock Issued to Former Officer | - | - | 63,068 | 63 | 277,436 | 277,499 | ||||||||||||||||||||||||||
| Foreign currency translation adjustment | - | - | - | - | - | 304,566 | - | 304,566 | ||||||||||||||||||||||||
Net Income | - | - | - | - | - | - | 1,752,346 | 1,752,346 | ||||||||||||||||||||||||
| Balance, July 31, 2018 | 1,000 | $ | 1 | 10,415,416 | $ | 10,415 | $ | 58,485,853 | $ | (1,733,865 | ) | $ | (35,230,591 | ) | $ | 21,531,813 | ||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements
| 6 |
CODA OCTOPUS GROUP, INC.
Consolidated Statements of Cash Flows
For the Periods Indicated
Unaudited
| Nine Months Ended July 31, | ||||||||
| 2018 | 2017 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
| Net income | $ | 1,752,346 | $ | 3,971,728 | ||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
| Depreciation and amortization | 605,645 | 631,062 | ||||||
| Stock compensation | 334,749 | 86,930 | ||||||
| Realized gain on the sale of fixed assets | - | (81,494 | ) | |||||
| (Increase) decrease in operating assets: | ||||||||
| Accounts receivable | (2,343,834 | ) | 740,734 | |||||
| Inventory | (535,657 | ) | (298,842 | ) | ||||
| Unbilled receivables | 373,301 |
(326,421 | ) | |||||
| Other current assets | 206,955 | (241,044 | ) | |||||
| Prepaid expenses | 106,812 | (92,296 | ) | |||||
| Deferred tax assets | - | 85,712 | ||||||
| (Decrease) in operating liabilities: | ||||||||
| Accounts payable and other current liabilities | (47,392 | ) | (119,748 | ) | ||||
| Deferred revenues | (126,256 | ) | (148,661 | ) | ||||
| Net Cash provided by Operating Activities | 326,669 | 4,207,660 | ||||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
| Purchases of property and equipment | (442,041 | ) | (2,649,060 | ) | ||||
| Proceeds from the sale of fixed assets | - | 525,275 | ||||||
| Restricted cash | - | 13,695 | ||||||
| Net Cash (used in) Investing Activities | (442,041 | ) | (2,110,090 | ) | ||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
| Repayments - loans and notes payable | (5,642,202 | ) | (384,202 | ) | ||||
| Issuance of stock for cash | 5,312,732 | - | ||||||
| Redemption of Series C preferred stock | - | (1,100,000 | ) | |||||
| Net Cash (used in) Financing Activities | (329,470 | ) | (1,484,202 | ) | ||||
EFFECT OF CURRENCY EXCHANGE RATE ON CHANGES IN CASH |
304,566 | 781,194 | ||||||
| NET (DECREASE) INCREASE IN CASH | (140,276 | ) | 1,394,562 | |||||
| CASH AT THE BEGINNING OF THE PERIOD | 6,851,539 | 5,601,767 | ||||||
| CASH AT THE END OF THE PERIOD | $ | 6,711,263 | $ | 6,996,329 | ||||
| SUPPLEMENTAL CASH FLOW INFORMATION | ||||||||
| Cash paid for interest | $ | 178,785 | $ | 464,705 | ||||
| Non-cash transactions | ||||||||
| Preferred stock issued for accrued interest | $ | - | $ | 1,000,000 | ||||
| Payment of secured debt directly with proceeds of note payable | $ | - | $ | 8,000,000 | ||||
The accompanying notes are an integral part of these consolidated financial statements
| 7 |
CODA OCTOPUS GROUP, INC.
Notes to the Unaudited Consolidated Financial Statements
July 31, 2018 and 2017
NOTE 1 – BASIS OF PRESENTATION
The accompanying unaudited interim consolidated financial statements have been prepared based upon U.S. Securities and Exchange Commission rules that permit reduced disclosure for interim periods. Therefore, they do not include all information and footnote disclosures necessary for a complete presentation of Coda Octopus Group, Inc.’s financial position, results of operations and cash flows, in conformity with generally accepted accounting principles. Coda Octopus Group, Inc. (“the Company”, “Coda Octopus,” “we,” or “us”) filed audited consolidated financial statements as of and for the fiscal years ended October 31, 2017 and 2016 which included all information and notes necessary for such complete presentation in conjunction with its report on Form 10-K filed on January 30, 2018 (the “Form 10-K”). The results of operations for the interim period ended July 31, 2018 are not necessarily indicative of the results to be expected for any future period or the entire fiscal year. These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended October 31, 2017, which are contained in the Company’s report on Form 10-K. The accompanying unaudited interim consolidated financial statements contain all adjustments (consisting of normal recurring items) which are, in the opinion of management, necessary for a fair statement of the Company’s financial position as of July 31, 2018 and the results of operations, comprehensive income and cash flows for the interim periods ended July 31, 2018 and 2017. The unaudited interim consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. The Company uses the US dollar as the reporting currency for financial reporting. The financial position and results of operations of the Company’s UK-based operations are measured using the British Pound Sterling, Australian based operations are measured using Australian Dollars and Norwegian based operations are measured using Norwegian Kroner as the functional currencies. Foreign currency translation gains and losses are recorded as a change in other comprehensive income. Transaction gains and losses generated from the remeasurement of assets and liabilities denominated in currencies other than the functional currency of our foreign operations are also included in other comprehensive income.
NOTE 2 – FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company’s short term financial instruments consist of cash and cash equivalents, receivables, accounts payable and the line of credit. The Company adjusts the carrying value of financial assets and liabilities denominated in other currencies such as cash, receivables, accounts payable and the line of credit using the appropriate exchange rates at the balance sheet date. The Company believes that the carrying values of these short term financial instruments approximate their estimated fair values.
NOTE 3 – FOREIGN CURRENCY TRANSLATION
The financial position and results of operations of the Company’s foreign subsidiaries are measured using the local currency as the functional currency. Assets and liabilities of operations denominated in foreign currencies are translated into U.S. dollars at exchange rates in effect at the balance sheet date, while revenues and expenses are translated at the weighted average exchange rates during the period. The resulting translation gains and losses on assets and liabilities are recorded in accumulated other comprehensive income (loss), and are excluded from net income until realized through a sale or liquidation of the investment.
| 8 |
CODA OCTOPUS GROUP, INC.
Notes to the Unaudited Consolidated Financial Statements
July 31, 2018 and 2017
NOTE 4 – INVENTORY
Inventory is stated at the lower of cost (weighted average method) or net realizable value. Inventory consisted of the following components:
| July 31, 2018 | October 31, 2017 | |||||||
| Raw materials and parts | $ | 3,385,859 | $ | 2,651,511 | ||||
| Work in progress | 227,473 | 501,692 | ||||||
| Demo goods | - | 349,480 | ||||||
| Finished goods | 574,574 | 149,566 | ||||||
| Total Inventory | $ | 4,187,906 | $ | 3,652,249 | ||||
NOTE 5 – OTHER CURRENT ASSETS
Other current assets consisted of the following components:
| July 31, 2018 | October 31, 2017 | |||||||
| Deposits | $ | 10,250 | $ | 11,255 | ||||
| Other receivables | 45,000 | 73,600 | ||||||
| Value added tax (VAT) receivable | 58,608 | 235,959 | ||||||
| Total Other Current Assets | $ | 113,859 | $ | 320,814 | ||||
NOTE 6 – ESTIMATES
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues including unbilled and deferred revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates include costs and earnings in excess of billings, billings in excess of costs and estimated earnings, valuation of accounts receivables, valuation of inventory, valuation of deferred tax assets (DTA’s) and the valuation of goodwill.
| 9 |
CODA OCTOPUS GROUP, INC.
Notes to the Unaudited Consolidated Financial Statements
July 31, 2018 and 2017
NOTE 7 – CONTRACTS IN PROGRESS
Costs and estimated earnings in excess of billings on uncompleted contracts represent accumulated project expenses and fees which have not been invoiced to customers as of the date of the balance sheet. These amounts are stated on the consolidated balance sheets as Unbilled Receivables of $2,349,871 and $2,723,172 as of July 31, 2018 and October 31, 2017, respectively.
Our Deferred Revenue of $325,842 and $452,098 as of July 31, 2018 and October 31, 2017, respectively, consists of billings in excess of costs and estimated earnings and revenues received as part of our warranty obligations upon completing a sale – elaborated further in the last paragraph of this note.
Billings in excess of cost and estimated earnings on uncompleted contracts represent project invoices billed to customers that have not been earned as of the date of the balance sheets. These amounts are stated on the balance sheets as a component of Deferred Revenue of $1,838 and $0 as of July 31, 2018 and October 31, 2017, respectively.
Revenue received as part of sales of equipment includes a provision for warranty and is treated as deferred revenue, along with extended warranty sales, and Through Life Support (which is a support package (for major software upgrades, service and technical support for the life cycle of the product) with these amounts amortized over 12 months, our stated warranty period, from the date of sale and 60 months for Through Life Support. These amounts are stated on the balance sheets as a component of Deferred Revenue of $79,205 and $76,574 as of July 31, 2018 and October 31, 2017, respectively.
NOTE 8 – CONCENTRATIONS
Significant Customers
During the three months ended July 31, 2018, the Company had one customer from whom it generated sales greater than 10% of net revenues. Revenue from this customer was $1,113,389, or 19% of net revenues during the period. Total accounts receivable from this customer at July 31, 2018 was $62,218 or 2% of accounts receivable.
During the three months ended July 31, 2017, the Company had one customer from whom it generated sales greater than 10% of net revenues. Revenue from this customer was $1,107,723, or 22% of net revenues during the period. Total accounts receivable from this customer at July 31, 2017 was $605,831 or 24% of accounts receivable.
During the nine months ended July 31, 2018, the Company had one customer from whom it generated sales greater than 10% of net revenues. Revenue from this customer was $2,138,815, or 17% of net revenues during the period. Total accounts receivable from this customer at July 31, 2018 was $62,218 or 2% of accounts receivable.
During the nine months ended July 31, 2017, the Company had one customer from whom it generated sales greater than 10% of net revenues. Revenue from this customer was $3,961,648, or 25% of net revenues during the period. Total accounts receivable from this customer at July 31, 2017 was $605,831 or 24% of accounts receivable.
| 10 |
CODA OCTOPUS GROUP, INC.
Notes to the Unaudited Consolidated Financial Statements
July 31, 2018 and 2017
NOTE 9 – LOANS AND NOTES PAYABLE
| July 31, 2018 | October 31, 2017 | |||||||
| Secured note payable to HSBC with interest payable on the 28th day of each month at 4.56% per annum. On March 28, 2018 the Company prepaid a portion of the principal thereby reducing the principal outstanding under this loan to $1,917,602 resulting in the repayment obligations (principal and interest payments) being reduced to $43,777 per month. It is now expected that the Loan will be repaid within 41 months. There was no prepayment penalty associated with the reduction of the principal. | $ | 1,637,151 | $ | 7,279,353 | ||||
One of our subsidiaries has an unsecured working capital loan from the CEO of the Company. The note is due on November 30, 2018 and carries an interest rate of 4.5%. | 1,000,000 | 1,000,000 | ||||||
| Total | 2,637,151 | 8,279,353 | ||||||
| Less: current portion | (1,459,326 | ) | (2,212,951 | ) | ||||
| Total Long-Term Loans and Notes Payable | $ | 1,177,825 | $ | 6,066,402 | ||||
We have an unused line of credit for up to $455,000 with HSBC UK to use specifically for bank guarantees. As of July 31, 2018 the balance is $0.
NOTE 10– ACCUMULATED OTHER COMPREHENSIVE INCOME
| July 31, 2018 | October 31, 2017 | |||||||
| Balance, beginning of year | $ | (2,038,431 | ) | $ | (2,337,437 | ) | ||
| Total other comprehensive income for the year - foreign currency translation adjustment | 304,566 | 299,006 | ||||||
| Balance, end of period | $ | (1,733,865 | ) | $ | (2,038,431 | ) | ||
NOTE 11 – RECENT ACCOUNTING PRONOUNCEMENTS
On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, requiring an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, which deferred the effective date of the new revenue standard for periods beginning after December 15, 2016 to December 15, 2017, with early adoption permitted but not earlier than the original effective date. We have evaluated the effects of this updated standard and determined that it will not have a significant impact on our consolidated financial statements and related disclosures.
| 11 |
CODA OCTOPUS GROUP, INC.
Notes to the Unaudited Consolidated Financial Statements
July 31, 2018 and 2017
NOTE 11– RECENT ACCOUNTING PRONOUNCEMENTS (Continued)
On February 24, 2016, the FASB issued ASU No. 2016-02, Leases, requiring lessees to recognize a right-of-use asset and a lease liability on the balance sheet for all leases with the exception of short-term leases. For lessees, leases will continue to be classified as either operating or finance leases in the income statement. Lessor accounting is similar to the current model but updated to align with certain changes to the lessee model. Lessors will continue to classify leases as operating, direct financing or sales-type leases. The effective date of the new standard for public companies is for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption is permitted. We have evaluated the effects of this updated standard and determined that it will not have a significant impact on our consolidated financial statements and related disclosures.
On March 30, 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which simplifies various aspects related to the accounting and presentation of share-based payments. The amendments require entities to record all tax effects related to share-based payments at settlement or expiration through the income statement and the windfall tax benefit to be recorded when it arises, subject to normal valuation allowance considerations. All tax-related cash flows resulting from share-based payments are required to be reported as operating activities in the statement of cash flows. The updates relating to the income tax effects of the share-based payments including the cash flow presentation must be adopted either prospectively or retrospectively. Further, the amendments allow the entities to make an accounting policy election to either estimate forfeitures or recognize forfeitures as they occur. If an election is made, the change to recognize forfeitures as they occur must be adopted using a modified retrospective approach with a cumulative effect adjustment recorded to opening retained earnings. The effective date of the new standard for public companies is for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years. Early adoption is permitted. We have implemented the pronouncement and have determined that it will not have a significant impact on our consolidated financial statements and related disclosures.
With the exception of the updated standards discussed above, there have been no new accounting pronouncements not yet effective that have significance, or potential significance, to our consolidated financial statements.
| 12 |
CODA OCTOPUS GROUP, INC.
Notes to the Unaudited Consolidated Financial Statements
July 31, 2018 and 2017
NOTE 12 – EARNINGS PER COMMON SHARE
| Three Months | Three Months | Nine Months | Nine Months | |||||||||||||
| Ended | Ended | Ended | Ended | |||||||||||||
| Fiscal Period | July 31 2018 | July 31 2017 | July 31 2018 | July 31 2017 | ||||||||||||
| Numerator: | ||||||||||||||||
| Net (Loss) Income | $ | 1,997,610 | $ | 1,124,802 | $ | 1,752,346 | $ | 3,971,728 | ||||||||
| Denominator: | ||||||||||||||||
| Basic weighted average common shares outstanding | 10,415,416 | 9,110,674 | 9,976,917 | 9,104,890 | ||||||||||||
| Conversion of Series C Preferred Stock | 200,000 | 200,000 | 200,000 | 200,000 | ||||||||||||
| Diluted outstanding shares | 10,615,416 | 9,310,674 | 10,176,917 | 9,304,890 | ||||||||||||
| Earnings from continuing operations | ||||||||||||||||
| Basic | $ | 0.19 | $ | 0.12 | $ | 0.18 | $ | 0.44 | ||||||||
| Diluted | $ | 0.19 | $ | 0.12 | $ | 0.17 | $ | 0.43 | ||||||||
| 13 |
CODA OCTOPUS GROUP, INC.
Notes to the Unaudited Consolidated Financial Statements
July 31, 2018 and 2017
NOTE 13 – SEGMENT ANALYSIS
We are operating in two reportable segments, which are managed separately based upon fundamental differences in their operations. Coda Octopus Martech and Coda Octopus Colmek (together “Marine Engineering Business” or “Services Segment”) operate as contractors, and the balance of our operations are comprised of product sales (“Marine Technology Business” or “Products Segment”).
Segment operating income is total segment revenue reduced by operating expenses identifiable with the business segment. Corporate includes general corporate administrative costs (overheads).
The Company evaluates performance and allocates resources based upon operating income. The accounting policies of the reportable segments are the same as those described in the summary of accounting policies in our Consolidated Financial Statements of October 31, 2017.
There are inter-segment sales which have been eliminated in our financial statements but are disclosed in the tables below for information purposes.
The following table summarizes segment asset and operating balances by reportable segment as of and for the three and nine months ended July 31, 2018 and 2017 respectively.
The Company’s reportable business segments operate in three geographic locations. Those geographic locations are:
* United States
* Europe
* Australia
Information concerning principal geographic areas according to the area where the activity has taken place for the three and nine months ended July 31, 2018 and 2017, respectively is presented below:
| 14 |
CODA OCTOPUS GROUP, INC.
Notes to the Unaudited Consolidated Financial Statements
July 31, 2018 and 2017
NOTE 13 – SEGMENT ANALYSIS (continued)
| Marine Technology Business (Products) | Marine Engineering Business (Services) | Overhead | Total | |||||||||||||
| Three Months Ended July 31, 2018 | ||||||||||||||||
| Revenues from External Customers | $ | 3,926,491 | $ | 1,851,982 | $ | - | $ | 5,778,473 | ||||||||
| Cost of Revenues | 650,669 | 933,531 | - | 1,584,200 | ||||||||||||
| Gross Profit | 3,275,822 | 918,451 | - | 4,194,273 | ||||||||||||
| Research & Development | 440,202 | 90,190 | - | 530,392 | ||||||||||||
| Selling, General & Administrative | 723,155 | 566,692 | 350,995 | 1,640,842 | ||||||||||||
| Total Operating Expenses | 1,163,357 | 656,882 | 350,995 | 2,171,234 | ||||||||||||
Income (Loss) from Operations | 2,112,465 | 261,569 | (350,995 | ) | 2,023,039 | |||||||||||
| Other Income (Expense) | ||||||||||||||||
| Other Income | 3,941 | 31 | - | 3,972 | ||||||||||||
| Interest Expense | (2,480 | ) | (15,802 | ) | (11,139 | ) | (29,421 | ) | ||||||||
Total Other Income (Expense) | 1,461 | (15,771 | ) | (11,139 | ) | (25,449 | ) | |||||||||
Net Income (Loss) before income taxes | 2,113,926 | 245,798 | (362,134 | ) | 1,997,590 | |||||||||||
Income tax Refund | - | - | 20 | 20 | ||||||||||||
| Net Income (Loss) | $ | 2,113,926 | $ | 245,798 | $ | (362,114 | ) | $ | 1,997,610 | |||||||
| Supplemental Disclosures | ||||||||||||||||
| Total Assets | $ | 14,016,131 | $ | 11,378,558 | $ | 553,927 | $ | 25,948,616 | ||||||||
| Total Liabilities | $ | 865,138 | $ | 1,660,291 | $ | 1,891,374 | $ | 4,416,803 | ||||||||
| Revenues from Intercompany Sales - eliminated from sales above | $ | 44,180 | $ | 183,800 | $ | 675,000 | $ | 902,980 | ||||||||
| Depreciation and Amortization | $ | 137,426 | $ | 66,435 | $ | 5,728 | $ | 209,589 | ||||||||
| Purchases of Long-lived Assets | $ | 232,575 | $ | (6,122 | ) | $ | 30,667 | $ | 257,120 | |||||||
| 15 |
CODA OCTOPUS GROUP, INC.
Notes to the Unaudited Consolidated Financial Statements
July 31, 2018 and 2017
NOTE 13 – SEGMENT ANALYSIS (continued)
| Marine Technology Business (Products) | Marine Engineering Business (Services) | Overhead | Total | |||||||||||||
| Three Months Ended July 31, 2017 | ||||||||||||||||
| Revenues from External Customers | $ | 3,439,587 | $ | 1,604,003 | $ | - | $ | 5,043,590 | ||||||||
| Cost of Revenues | 1,054,369 | 928,392 | - | 1,982,761 | ||||||||||||
| Gross Profit | 2,385,218 | 675,611 | - | 3,060,829 | ||||||||||||
| Research & Development | 200,118 | - | - | 200,118 | ||||||||||||
| Selling, General & Administrative | 781,908 | 637,465 | 297,891 | 1,717,264 | ||||||||||||
| Total Operating Expenses | 982,026 | 637,465 | 297,891 | 1,917,382 | ||||||||||||
Income (Loss) from Operations | 1,403,192 | 38,146 | (297,891 | ) | 1,143,447 | |||||||||||
| Other Income (Expense) | ||||||||||||||||
| Other Income | 89,670 | 261 | - | 89,931 | ||||||||||||
| Interest Expense | (5,947 | ) | (15,451 | ) | (90,691 | ) | (112,089 | ) | ||||||||
Total Other Income (Expense) | 83,723 | (15,190 | ) | (90,691 | ) | (22,158 | ) | |||||||||
Net Income (Loss) before income taxes | 1,486,915 | 22,956 | (388,582 | ) | 1,121,289 | |||||||||||
Income Refund | 3,513 | - | - | 3,513 | ||||||||||||
| Net Income (Loss) | $ | 1,490,428 | $ | 22,956 | $ | (388,582 | ) | $ | 1,124,802 | |||||||
| Supplemental Disclosures | ||||||||||||||||
| Total Assets | $ | 12,300,376 | $ | 12,529,169 | $ | 1,093,219 | $ | 25,922,764 | ||||||||
| Total Liabilities | $ | 1,103,023 | $ | 1,638,002 | $ | 8,287,374 | $ | 11,028,399 | ||||||||
| Revenues from Intercompany Sales - eliminated from sales above | $ | 1,002,339 | $ | 36,030 | $ | 369,625 | $ | 1,407,994 | ||||||||
| Depreciation and Amortization | $ | 130,048 | $ | 101,442 | $ | 3,211 | $ | 234,701 | ||||||||
| Purchases of Long-lived Assets | $ | 252,653 | $ | 45,841 | $ | - | $ | 298,494 | ||||||||
| 16 |
CODA OCTOPUS GROUP, INC.
Notes to the Unaudited Consolidated Financial Statements
July 31, 2018 and 2017
NOTE 13 – SEGMENT ANALYSIS (continued)
| Marine Technology Business (Products) | Marine Engineering Business (Services) | Overhead | Total | |||||||||||||
| Nine Months Ended July 31, 2018 | ||||||||||||||||
| Revenues from External Customers | $ | 8,142,724 | $ | 4,212,702 | $ | - | $ | 12,355,426 | ||||||||
| Cost of Revenues | 1,298,022 | 2,173,143 | - | 3,471,165 | ||||||||||||
| Gross Profit | 6,844,702 | 2,039,559 | - | 8,884,261 | ||||||||||||
| Research & Development | 1,385,994 | 455,414 | - | 1,841,408 | ||||||||||||
| Selling, General & Administrative | 2,150,168 | 1,813,357 | 1,208,704 | 5,172,229 | ||||||||||||
| Total Operating Expenses | 3,536,162 | 2,268,771 | 1,208,704 | 7,013,637 | ||||||||||||
Income (Loss) from Operations | 3,308,540 | (229,212 | ) | (1,208,704 | ) | 1,870,624 | ||||||||||
| Other Income (Expense) | ||||||||||||||||
| Other Income | 92,514 | 2,128 | - | 94,642 | ||||||||||||
| Interest (Expense) Income | (9,289 | ) | (45,503 | ) | (158,118 | ) | (212,910 | ) | ||||||||
Total Other Income (Expense) | 83,225 | (43,375 | ) | (158,118 | ) | (118,268 | ) | |||||||||
Net Income (Loss) before income taxes | 3,391,765 | (272,587 | ) | (1,366,822 | ) | 1,752,356 | ||||||||||
Income Refund (expense) | (6,596 | ) | - | 6,586 | (10 | ) | ||||||||||
| Net Income (Loss) | $ | 3,385,169 | $ | (272,587 | ) | $ | (1,360,236 | ) | $ | 1,752,346 | ||||||
| Supplemental Disclosures | ||||||||||||||||
| Total Assets | $ | 14,016,131 | $ | 11,378,558 | $ | 553,927 | $ | 25,948,616 | ||||||||
| Total Liabilities | $ | 865,138 | $ | 1,660,291 | $ | 1,891,374 | $ | 4,416,803 | ||||||||
| Revenues from Intercompany Sales - eliminated from sales above | $ | 831,352 | $ | 196,103 | $ | 2,025,000 | $ | 3,052,455 | ||||||||
| Depreciation and Amortization | $ | 374,076 | $ | 218,649 | $ | 12,920 | $ | 605,645 | ||||||||
| Purchases of Long-lived Assets | $ | 486,604 | $ | 43,839 | $ | 55,452 | $ | 585,895 | ||||||||
| 17 |
CODA OCTOPUS GROUP, INC.
Notes to the Unaudited Consolidated Financial Statements
July 31, 2018 and 2017
NOTE 13 – SEGMENT ANALYSIS (continued)
| Marine Technology Business (Products) | Marine Engineering Business (Services) | Overhead | Total | |||||||||||||
| Nine Months Ended July 31, 2017 | ||||||||||||||||
| Revenues from External Customers | $ | 9,189,731 | $ | 6,490,820 | $ | - | $ | 15,680,551 | ||||||||
| Cost of Revenues | 2,753,297 | 3,226,449 | - | 5,979,746 | ||||||||||||
| Gross Profit | 6,436,434 | 3,264,371 | - | 9,700,805 | ||||||||||||
| Research & Development | 699,106 | - | - | 699,106 | ||||||||||||
| Selling, General & Administrative | 2,165,601 | 1,979,436 | 596,931 | 4,741,968 | ||||||||||||
| Total Operating Expenses | 2,864,707 | 1,979,436 | 596,931 | 5,441,074 | ||||||||||||
Income (Loss) from Operations | 3,571,727 | 1,284,935 | -596,931 | 4,259,731 | ||||||||||||
| Other Income (Expense) | ||||||||||||||||
| Other Income | 204,653 | 261 | - | 204,914 | ||||||||||||
| Interest Expense | (538,088 | ) | (214,674 | ) | 256,332 | (496,430 | ) | |||||||||
Total Other Income (expense) | (333,435 | ) | (214,413 | ) | 256,332 | (291,516 | ) | |||||||||
| Income before income taxes | 3,238,292 | 1,070,522 | (340,599 | ) | 3,968,215 | |||||||||||
Income Refund (expense) | 3,513 | - | - | 3,513 | ||||||||||||
| Net Income | $ | 3,241,805 | $ | 1,070,522 | $ | (340,599 | ) | $ | 3,971,728 | |||||||
| Supplemental Disclosures | ||||||||||||||||
| Total Assets | $ | 12,300,376 | $ | 12,529,169 | $ | 1,093,219 | $ | 25,922,764 | ||||||||
| Total Liabilities | $ | 1,103,023 | $ | 1,638,002 | $ | 8,287,374 | $ | 11,028,399 | ||||||||
| Revenues from Intercompany Sales - eliminated from sales above | $ | 1,680,852 | $ | 265,985 | $ | 607,375 | $ | 2,554,212 | ||||||||
| Depreciation and Amortization | $ | 377,311 | $ | 244,223 | $ | 9,528 | $ | 631,062 | ||||||||
| Purchases of Long-lived Assets | $ | 2,541,716 | $ | 94,874 | $ | 12,470 | $ | 2,649,060 | ||||||||
| 18 |
CODA OCTOPUS GROUP, INC.
Notes to the Unaudited Consolidated Financial Statements
July 31, 2018 and 2017
NOTE 13 – SEGMENT ANALYSIS (continued)
| USA | Europe | Australia | Total | |||||||||||||
| External Revenues by Geographic Locations | ||||||||||||||||
| Three Months Ended July 31, 2018 | $ | 2,060,203 | $ | 3,718,877 | $ | (607 | ) | $ | 5,778,473 | |||||||
| Three Months Ended July 31, 2017 | $ | 1,550,141 | $ | 2,942,364 | $ | 551,085 | $ | 5,043,590 | ||||||||
| Nine Months Ended July 31, 2018 | $ | 5,082,194 | $ | 7,017,581 | $ | 255,651 | $ | 12,355,426 | ||||||||
| Nine Months Ended July 31, 2017 | $ | 6,825,815 | $ | 7,574,299 | $ | 1,280,437 | $ | 15,680,551 | ||||||||
NOTE 14 – Private Placement and Stock Issuances
Between January 29, 2018 and February 12, 2018, the Company consummated the sale and issuance of 1,203,727 shares of its common stock in a private placement of shares of common stock at $4.40 per share (the “Offering”). Total gross proceeds from the Offering were $5,312,732. The purchase price per share was based on a 10% discount of the volume weighted average price (VWAP) of the common stock on the Nasdaq Capital Market for the 30-consecutive trading-day period ending on January 22, 2018. The total number of shares sold also included 75,000 shares of common stock sold to one of the Company’s directors at $4.61 per share, representing the consolidated closing bid price of the Company’s common stock on February 2, 2018.
In accordance with the terms of the Offering, the Company filed a re-sale registration statement with respect to the shares issued in the Offering which was declared effective on May 2, 2018. For a period of 36 months, the investors also have the right to purchase, based on their pro-rata ownership of common stock, shares (or securities convertible into shares) offered in subsequent offerings, subject to certain limited exceptions.
On or around April 19, 2018, the Company issued an aggregate of 63,068 shares of its common stock at a value of $4.40 for each share to an ex-employee pursuant to the terms of a settlement agreement entered into on or around January 14, 2011.
Pursuant to an agreement entered into in June 2017, on February 1, 2018 the Company issued an aggregate of 6,250 shares of its common stock to two consultants for services rendered at a value of $4.62 for each share of common stock.
Pursuant to an agreement entered into in June 2017, on March 6, 2018 the Company issued an aggregate of 6,250 shares of its common stock to two consultants for services rendered at a value of $4.54 for each share of common stock.
NOTE 15 – INCOME TAXES
On December 22, 2017, the US Congress passed the Tax Cuts and Jobs Act, which reduced the corporate tax rate from 39% to 21%. This change would reduce the deferred tax asset, from $4,270,500 to $2,299,500 as of October 31, 2017. The Company has provided a full valuation allowance against the deferred tax asset. This tax law change will not impact these consolidated financial statements. However, should our deferred tax asset reverse, we will not recognize benefits in the amount previously expected.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
The information herein contains forward-looking statements. All statements other than statements of historical fact made herein are forward looking. In particular, the statements herein regarding industry prospects and future results of operations or financial position are forward-looking statements. These forward-looking statements can be identified by the use of words such as “believes,” “estimates,” “could,” “possibly,” “probably,” anticipates,” “projects,” “expects,” “may,” “will,” or “should” or other variations or similar words. No assurances can be given that the future results anticipated by the forward-looking statements will be achieved. Forward-looking statements reflect management’s current expectations and are inherently uncertain. Our actual results may differ significantly from management’s expectations.
The following discussion and analysis should be read in conjunction with our financial statements, included herewith and the audited financial statements included in our Form 10-K filed with the Securities and Exchange Commission on January 30, 2018. This discussion should not be construed to imply that the results discussed herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of actual operating results in the future. Such discussion represents only the best present assessment of our management.
General Overview
Throughout these discussions, the following terminologies listed in the table immediately below are used and have the meanings ascribed to them in the said table.
| “Current Quarter” | The three month period ended July 31, 2018 |
| “Previous Quarter” | The three month period ended July 31, 2017 |
| “Current Nine Month Period” | The nine month period ended July 31, 2018 |
| “Previous Nine Month Period” | The nine month period ended July 31, 2017 |
We operate two distinct business segments. Our Products Segment designs and manufactures patented real time 3D sonar solutions and other leading products for subsea applications (“Products Segment”). Our Services Segment supplies engineering services to prime defense contractors (“Services Segment”).
The Products Segment products are used primarily in the underwater construction market, offshore oil and gas, offshore wind energy industry, and in the complex dredging, port security, defense, mining and marine sciences sectors. Our customers include service providers to major oil and gas companies, law enforcement agencies, ports, mining companies, defense bodies, research institutes and universities.
Our Services segment supplies engineering services mainly to prime defense contractors such as Raytheon and Northrop Grumman. We have long-standing relationships with prime defense contractors. We support some significant defense programs by supplying and maintaining proprietary parts through obsolescence management programs. These services provide recurring stream of revenues for our Services segment.
Both Segments’ revenues declined in the Current Nine Month Period compared to the Previous Nine Month Period. Despite this decline and significant increases in SG&A (which includes on a consolidated year to date basis non-recurring costs of $740,486) and R&D expenditures, we realized a net income in the Current Nine Month Period of $1,752,346 compared to net income in the Previous Nine Month of $3,971,728.
| Products Segment | In the Current Quarter, this segment generated 68% of our overall revenues realized in the Current Quarter. |
In the Previous Quarter, this segment generated 68% of our overall revenues realized in the Previous Quarter. | ||
| Products Segment | In the Current Nine Month Period, this segment generated 66% of our overall revenues realized in the nine month period of 2018. | In the Previous Nine Month Period, this segment generated 59% of our overall revenues realized in the nine month period of 2017. | ||
| Services Segment | In the Current Quarter, this segment generated 32% of our overall revenues realized in the Current Quarter |
In the Previous Quarter, this segment generated 32% of our overall revenues realized in the Previous Quarter. | ||
| Services Segment | In the Current Nine Month Period, this segment generated 34% of our overall revenues realized in the nine month period of 2018. | In the Previous Nine Month Period, this segment generated 41% of our overall revenues realized in the nine month period of 2017. |
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In the Current Quarter, revenues in the Services Segment increased by 15% compared to the Previous Quarter. Although in the Current Quarter the Services Segment realized an increase in its revenues compared to the Previous Quarter, on an annualized basis this segment is behind in its revenues plan due to ongoing delays in the US administration approving the government budget. The US Defense Budget is now in place and the Services Segment is currently negotiating a number of contracts with defense customers which relate to backlog orders for calendar years 2016, 2017 and 2018. We have received some of the backlog orders pertaining to calendar year 2016 (approximately $1.7m) but we are still negotiating contracts for backlog orders for 2017 and 2018. Until the negotiations are completed, the contracts will not be awarded. We anticipate that some of these contracts will be awarded to us by our customers in the fourth quarter of this fiscal year. Although our backlog of orders is set to grow, we expect our revenues and overall earnings from the Services Segment to be weak in this fiscal year of the Company.
During the Current Quarter revenues in the Products Segment increased by 14% compared to the Previous Quarter. This is largely due to an increase in order take in the Current Quarter in contrast to our order take in the first and second quarters of this fiscal year which was weak due to customers delaying purchasing decisions in the first and second quarters of this fiscal year, until the finalization of the biggest trade show for the industry in which we operate, and which was held in March 2018 (“Oceanology 2018”). It is our experience that leading up to this trade show (which is held every two years), in the first and second quarter, our customers will not place orders as they are waiting to see if “new products and technology” are unveiled at the trade show. This resulted in orders that we may have received in either the first or second quarters of our fiscal year, being placed in the third quarter instead. Consequently, order take in the Current Quarter was stronger than the Previous Quarter.
Despite the weak performance of our Products Segment in the first two quarters of this fiscal year, we continue to believe that our unique and patented real time 3D solutions are a significant advancement on the other technology available in the subsea sonar imaging market. This is due to its ability to provide real time volumetric data of underwater targets in low or zero visibility conditions and its capability to image moving objects in the subsea environment. Furthermore, because the technology provides real time imaging of the underwater environment, it enhances the safety of these operations significantly and delivers substantial productivity gains to our customers, thus reducing their costs.
In addition, our real time 3D solution is emerging as the preferred solutions for subsea asset placements because of the technology’s unique ability to image underwater moving targets (such as Accropodes™, X-Blocs and Antifers block placements, mattress placements, landing of installations on the seabed and the like). Due to the decline in the price of oil, many Oil and Gas (“O&G”) companies are seeking cost effective solutions for their operations. We believe that our real time 3D solution has the potential to revolutionize the technology used in underwater operations particularly where real time visualization is required or zero or low visibility conditions prevail.
We also believe that with the proliferation of underwater drones our technology has significant application for the imaging sonar defense market (which generates billions of dollars annually) as it is the only available off the shelf technology that can image moving targets (such as underwater vehicles) in the water.
Since introducing our patented real time 3D sonar product, we have made progress in getting this technology, (branded Echoscope®) adopted by a significant number of ports in the USA (the CodaOctopus® Underwater Inspection System which integrates our Echoscope®, our motion sensing product and a hydrographic pole) where it is used for port and harbor security. In addition to the successes we have had in the USA with our Underwater Inspection System, in 2015 we secured the first sale of our Underwater Inspection System to a foreign government body in East Asia and in 2016 we sold two additional systems to this body. We anticipate selling additional systems into this government body as part of their technology upgrade program for the next three years. Furthermore, we continue to increase the number of ports in the USA using this system and in fiscal year 2018 we have sold an additional Underwater Inspection System to a significant port on the west coast of the USA for a contract value of $664,765.
We have also made progress in expanding the markets (and applications) for our real time 3D sonars. Recently, we have sold a number of systems to mining companies. Increasingly, our customers involved in offshore wind energy and renewables are adopting the technology as the primary tool for scour management, subsea cable installation and associated cable protection tasks.
In addition, in recent years we have started to rent our real time 3D solutions together with engineering services. Given the contraction in capital expenditures budget in the O&G market, rentals are increasingly becoming an important part of the composition of the Company’s revenues as these O&G operators are more prepared to utilize operational budgets (as opposed to capital expenditures budgets). Furthermore, our rental offering generally yields a higher gross margin for the Company.
| 21 |
The re-innovation of the form factor through a reduction in size, weight and power requirements (SWaP) of our new fourth generation real time 3D sonar technology, now paves the way for entry into new markets where previously SWaP and price were significant barriers to entry.
Our business is affected by a number of factors including those set out below:
| A. | The Company’s operations are split between the United States, United Kingdom and Australia. A large proportion of our revenues (approximately 64% in the Current Quarter and 59% in the Current Nine Month Period) and costs are incurred outside of the USA with a significant part (64% of our total revenues in the Current Quarter and 57% in the Current Nine Month Period) in the United Kingdom (“UK”). In addition, a significant part of our assets (both current and fixed) are held in British Pounds by our foreign subsidiaries. The volatility in the exchange rate following the decision on Brexit (see below) exposes the Company to exchange rate fluctuations which may be adverse for its operations. As we move towards the finalization of the “Brexit” arrangement we could see much bigger currency swings and therefore the impact on our operations could become more severe due to downward pressure on the British Pound. |
| B. | On June 23, 2016, the United Kingdom voted to exit the European Union. This resulted in, amongst other things, significant currency exchange rate fluctuations and volatility in global stock markets including a sharp fall of the British Pound against the US Dollar and general uncertainty in the economy. The British government and the European Union are now negotiating the terms of the United Kingdom’s exit from the European Union (so-called “Brexit”). The United Kingdom’s separation could seriously impact on the overall performance of one of our key subsidiaries in the United Kingdom which constitute a significant part of our operations and, among other things, disrupt trade and the free movement of goods, services and people between the United Kingdom and the European Union or other countries as well as create legal and global economic uncertainty. |
| C. | Given the lack of comparable precedent, the implications of Brexit or how such implications might affect the Company in the medium to long term are unclear. |
Further areas of impact include:
| i. | the price of commodities, in particular O&G. The decline in O&G prices since 2014 with a partial recovery since 2016 has resulted in large scale reductions in capital and operational expenditures, which directly impact on the sales of our products into these and related markets and also our gross margins. Even though the price is rising, we have not seen the same level of expenditures from this sector since 2014; |
| ii. | the allocation of funds to defense procurement by governments in the United States and the United Kingdom; |
| iii. | approximately 64% of the Company’s revenues in the Current Quarter and 57% in the Current Nine Month Period are transacted and generated in British Pounds by the Company’s subsidiaries in the United Kingdom and therefore we have a significant currency exposure. The depreciation of the British Pound against major currencies, including the U.S Dollars which is our reporting currency, adversely impacts our revenues as a whole. Furthermore, a large part of our assets is held in British Pounds while the majority of our liabilities (which comprise our senior secured debentures – see Note 9 of the unaudited Consolidated Financial Statements) are maintained in U.S. Dollars. In the Current Quarter as compared to the Previous Quarter, we realized a modest balance sheet loss on our assets due to the depreciation of the British Pound against the US Dollar prevailing at the balance sheet date of July 31, 2018 and 2017, respectively. In the Current Quarter compared to the Previous Quarter, we also realized a modest loss on exchange rate translations in respect to revenues and expenses. The exchange rate applied to the valuation of our Balance Sheet at the end of the Quarter (exchange rate prevailing then) is different from the exchange rate applied to the profit and loss account transactions which are translated at the weighted average exchange rates during the period. See Note 3 of the unaudited Consolidated Financial Statements for more information on our Foreign Currency Translation policy. |
| iv. | global-political uncertainties affecting the markets into which we sell our goods and services; |
| v. | global trends which make certain geographical regions more competitive in providing engineering solutions because of lower labor costs (e.g. India and China) are likely to affect our Engineering Businesses in the Group; |
| vi. | because we are a small technology company, we are unable to compete for certain specialized electronic engineering skills as our remuneration package is not as competitive as those offered by bigger companies which require the same skills set; |
| 22 |
| vii. | the Company has issued an outstanding promissory note (See Note 9 of the unaudited Consolidated Financial Statements July 31, 2018 and 2017). This note is secured by all of the Company’s assets in the USA and is also guaranteed by its overseas subsidiaries although on or around March 28, 2018 we reduced the principal amount outstanding with HSBC NA significantly. As of July 31, 2018, the principal amount outstanding under this arrangement is $1,637,151(see Note 9 of the unaudited consolidated statements), and we therefore believe that this is at a level which should not pose a financial risk to the Company; |
| viii | we lack the financial resources to advance our flagship technology at the commercially appropriate pace and scale required to capture new markets and increase our sales which could facilitate new entrants to the market. For example, Teledyne Technologies Inc, a multi-billion dollar company, has recently acquired a number of subsea companies that may speed up their entry into our market; and |
| ix | a significant part of our growth strategy is predicated on our patented real time 3D sonar technology. The technology space is inherently uncertain due to the fast pace of innovations and therefore we can give no assurance that we can maintain our leading position in the real time 3D imaging sonar market or that innovations in other areas may not surpass our unique capability that we currently supply to subsea market. |
Critical Accounting Policies
This discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements that have been prepared under accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in conformity with US GAAP requires our management to make estimates and assumptions that affect the reported values of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported levels of revenue and expenses during the reporting period. Actual results could materially differ from those estimates.
Below is a discussion of accounting policies that we consider critical to an understanding of our financial condition and operating results and that may require complex judgment in their application or require estimates about matters which are inherently uncertain. A discussion of our significant accounting policies, including further discussion of the accounting policies described below, can be found in Note 2, “Summary of Accounting Policies” of our consolidated financial statements of October 31, 2017.
Revenue Recognition
Our revenue is derived from sales of underwater technologies and equipment for imaging, mapping, defense and survey applications and from the engineering services which we provide. Revenue is recognized when evidence of a contractual arrangement exists, delivery has occurred or services have been rendered, the contract price is fixed or determinable, and collectability is reasonably assured. No right of return privileges are granted to customers after delivery.
For arrangements with multiple deliverables, we recognize product revenue by allocating the revenue to each deliverable based on the relative fair value of each deliverable, and recognize revenue when equipment is delivered, and for installation and other services as they are performed.
Our contracts sometimes require customer payments in advance of revenue recognition. These amounts are reflected as liabilities and recognized as revenue when the Company has fulfilled its obligations under the respective contracts.
For software license sales for which any services rendered are not considered essential to the functionality of the software, we recognize revenue upon delivery of the software, provided (1) there is evidence of a contractual arrangement for this, (2) collection of our fee is considered probable and (3) the fee is fixed and determinable.
For arrangements that are generated from time and material contracts where there is a signed agreement and approved purchase order in place that specifies the fixed hourly rate and other reimbursable costs to be billed based on material and direct labor hours incurred, revenue is recognized on these contracts based on material and direct labor hours incurred. Revenues from fixed-price contracts are recognized on the percentage-of-completion method, measured by the percentage of costs incurred (materials and direct labor hours) to date to estimated total services (materials and direct labor hours) for each contract. This method is used as expenditures for direct materials and labor hours are considered to be the best available measure of progress on these contracts. Losses on fixed-price contracts are recognized during the period in which the loss first becomes apparent based upon costs incurred to date and the estimated costs to complete as determined by experience from similar contracts. Variations from estimated contract performance could result in adjustments to operating results.
| 23 |
Rental Revenue is recognized monthly over the term of the rental period.
Recoverability of Deferred Costs
We defer costs on projects for service revenue. Deferred costs consist primarily of direct and incremental costs to customize and install systems, as defined in individual customer contracts, including costs to acquire hardware and software from third parties and payroll costs for our employees and other third parties.
We recognize such costs in accordance with our revenue recognition policy by contract. For revenue recognized under the completed contract method, costs are deferred until the products are delivered, or upon completion of services or, where applicable, customer acceptance. For revenue recognized under the percentage of completion method, costs are recognized as products are delivered or services are provided in accordance with the percentage of completion calculation. For revenue recognized ratably over the term of the contract, costs are recognized ratably over the term of the contract, commencing on the date of revenue recognition. At each balance sheet date, we review deferred costs, to ensure they are ultimately recoverable. Any anticipated losses on uncompleted contracts are recognized when evidence indicates the estimated total cost of a contract exceeds its estimated total revenue.
Stock Based Compensation
We recognize the expense related to the fair value of stock based compensation awards within the consolidated statements of income and comprehensive income. We use the fair value method for equity instruments granted to non-employees and use the Black-Scholes model for measuring the fair value. The stock based fair value compensation is determined as of the date of the grant or the date at which the performance of the services is completed (measurement date) and is recognized over the periods in which the related services are rendered.
Income Taxes